Greed and Hype Are Causing Nasdaq's Turbulence

BOSTON (05/15/2000) - There's nothing like a spectacular run in the stock market to set pulses quickening, and a spectacular decline-like the recent one-to send everyone running for the antacids and tranquilizers. What's happening here? Is technology really just a hype phase in the market? Is the investment community just caught in its own excesses? No. There are two explanations for the Nasdaq plunge: greed and hype.

The greed part starts with venture capitals, which have funded the startups whose initial public offerings (IPO) have created many of the boom-then-bust stocks in the Nasdaq index. Where greed comes into play is that most of these new companies were never funded to succeed; they were funded to "flip."

In the lingo of the financial community, "flipping" means selling off an investment in a new company by selling the company to an established player, or to the public through an IPO, before the company has proven its value in the market. Flipping used to be a way for venture capitals to bail out on a company that wasn't going to perform well over the long term. In recent years, however, companies have been "born to be flipped," meaning they were funded only to be sold off quickly. The industry even came up with the name "burgers" to describe these companies.

The flip-exit approach to funding has increased the number of companies that are funded without concern for whether the concept they represent can ever succeed, so it's not surprising that most fail. In the past two years, I've seen the percentage of new companies seeking consulting services and possessing no possible long-term value increase from about 30 percent to nearly 60 percent. Because IPO candidates are drawn from this batch of burgers, it's not surprising that more and more fall short of Wall Street expectations - and fall precipitously in value. It's also not surprising that nontechnologists can't easily separate the good stuff from the baggage, and drag the whole technology sector down with indiscriminate selling.

What makes all this possible is hype. Many good companies are literally told they can't build something that would be long-term useful because it flies in the face of current market hype and reduces "flippability."

The strategy for success for too many venture capitals is to fund companies into a hype storm, let their perceived value explode and then flip them off before their weakness is exposed. The venture capitals and company insiders win, and the rest of us lose in the long run. But venture capitals didn't create the hype by themselves; they had lots of help.

The first group of hype contributors is the analyst community, of which I am a member. Analysts are routinely offered equity in new firms in return for their help, which makes them insiders in the company and thus beneficiaries of a flip play. These same analysts write about and are quoted about these firms - firms whose successes and failures the analysts will share. This doesn't exactly promote objectivity.

The second group of contributors is the press, where the problem is the "editorial agenda" of many publications. It's well known in the vendor and public relations communities that magazines have a story line they want to follow. Follow it and you get in the publication; defy it and you don't.

Companies bias their stories to suit the media's interest, so often they don't even present the real story. If they do tell the truth, a reporter may file a good story and have it killed in the editorial process. Or the reporter may miss the truth completely.

Every venture capital, analyst and reporter isn't guilty of these evils.

Nevertheless, falsehoods prevail where truth isn't anyone's priority. The Nasdaq may recover some of its value even if we proceed on our current path, but it will never reflect the true value of this industry when we actively hide what the truth is. If you want the technology market to thrive, make truth your priority. It's that simple.

Nolle is president of CIMI Corp., a technology assessment firm in Voorhees, New Jersey. He can be reached at (856) 753-0004 or tnolle@cimicorp.com.

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